Let’s Put Consumers in Charge of Health Care

View more from the

The Idea in Brief

For business, health care has become a lose-lose proposition: You pay way too much, and you get way too little. Despite massive company expenditures ($450 billion in premiums in 2000 alone), employees still lament the quality of care they receive, burdensome out-of-pocket expenses, and inadequate coverage.

The health care industry has been shielded from consumer pressure—by employers, insurers, and the government. As a result, costs have exploded as choices have narrowed.

There is a way out of this mess—if companies embrace a radical new treatment: consumer-driven health care. This new model places control over costs and care directly in the hands of employees by giving them more health-plan choices, greater control over what they spend on coverage, and more information for wiser choices.

To start the shift to consumer-driven health care, companies need to revamp their health benefits in six ways:

Give employees incentives to shop intelligently. “Give” them the sum you would have spent on benefits. Require them to spend some on insurance to cover financially catastrophic medical events. Let them spend the rest on other options (e.g., prescription or long-term-care coverage). By shopping as if they’re using their own money, employees tailor coverage to their needs.

Let providers set their own prices. When insurers set prices they pay providers for each discrete care “episode,” providers aren’t motivated to create bundles of integrated services, especially for chronic-disease sufferers. When providers determine prices, care quality improves, and costs fall. Example:

Buyers Health Care Action Group, a coalition of large employers, contracts with care teams (primary care physicians, specialists, hospitals) that determine their own policies and prices. Employers provide employees at least enough money to select the lowest-cost plan, plus coworker ratings of caregivers’ quality. In five years, the percentage of employees enrolled in high-cost groups fell from 70% to 17%. Overall, there was no reduction in quality of care, and quality increased for some chronic diseases and health-promoting activities.

Adjust payments for each enrollee based on need. When companies pay the same premiums for every employee, regardless of individuals’ health status, insurers and providers have no incentive to create innovative programs for the sick. To address this—without employers or employees paying more—use risk-adjusted pricing to vary payments according to individual employee’s care needs, through a neutral third-party that maintains employees’ privacy.

Provide relevant information. To help employees select coverage and care wisely, give them objective information about the quality of care provided by specific doctors, hospitals, and insurers.

The health insurance system in the United States is broken, and business is paying the price. Employers’ insurance premiums reached an estimated $450 billion in 2000, and then shot up again, at three times the rate of inflation, in 2001. With managed-care cost controls collapsing, patient-protection legislation promising to set off a round of expensive lawsuits, and costly genomic technologies on the horizon, the price of insurance is almost certain to continue its upward spiral in the years ahead. And what do companies get for their massive expenditures? A lot of unhappy employees. Workers fret about the quality of the care they receive, the burden of out-of-pocket expenses, and gaps in coverage for long-term care, prescriptions, and catastrophic illnesses. For business, health care has become a lose-lose proposition: You pay way too much, and you get way too little.

It wasn’t supposed to be like this. About 20 years ago, managed care was widely viewed as the silver bullet that would curb cost increases while ensuring patients good and convenient treatment. But managed care has been a bust. The original HMO models—vertically integrated systems for managing care or those that use gatekeepers to impose stringent controls on care—were resisted by patients and physicians. In response, the managed care organizations began relaxing their controls, allowing patients more freedom to see specialists and out-of-network doctors. Costs began to climb again, yet patients and providers continued to feel constrained. Now, no one’s happy—not the insurers, not the patients, not the doctors and nurses, not the hospitals, and certainly not the companies that are footing the bill.

The situation is dire, but there is a way out of the mess—and the key lies with the business community. If companies are willing to embrace a new model of health coverage—one that places control over costs and care directly in the hands of employees—the competitive forces that spur productivity and innovation in consumer markets can be loosed upon the inefficient, tradition-bound health care system. Rather than imposing a top-down solution, as managed care vainly tried to do, consumer-driven health care would work from the bottom up, enabling providers and patients jointly to create better, cheaper ways to deliver care.

When Consumers Take Control

When consumers apply pressure on an industry, whether it’s retailing or banking, cars or computers, it invariably produces a surge of innovation that increases productivity, reduces prices, improves quality, and expands choices. The essential problem with the health care industry is that it has been shielded from consumer control—by employers, insurers, and the government. As a result, costs have exploded as choices have narrowed. Today, approximately 40% of all employers and 92% of small ones offer employees only a single health insurance plan. And even when companies offer three or four options, precious little distinguishes them—most managed-care plans provide the same benefits, insure virtually identical levels of expenses, reimburse providers in similar ways for a limited array of traditional services, and last for only one year. In essence, managed care comes in just two flavors: plans that place constraints on access to physicians and hospitals for a lower price, and plans that offer readier access for a higher price. The lack of choice and control ensures that many consumers’ and providers’ needs go unmet and that industry inefficiency goes unchecked.

In many ways, the current health insurance model resembles the way companies used to manage their employees’ retirement savings. In traditional defined benefit plans, pension investments and returns were determined by employers; workers were given no choice, no control, and very little information. When employees began to manage their retirement savings using 401(k)s and other defined contribution plans that allowed them to invest pretax money, the effects were dramatic and far-reaching. First, the number and variety of investment choices skyrocketed, as new mutual fund companies rushed into the market with creative, differentiated offerings. Today, according to Institutional Investor, more than 90% of employers offer seven or more distinctly different investment options to their employees, ranging from indexed bond funds to microcap equity funds. Second, sources providing advice and information about mutual-fund investment results proliferated, with companies like Morningstar supplying individual investors with the data and advice they needed to make intelligent choices. Third, despite widespread fears that people would lack the financial acumen to manage their own savings, defined contribution returns outpaced those from defined benefit plans. Watson Wyatt, a benefits and compensation consultancy, determined that the returns of 401(k) plans exceeded those of defined benefit investments not only in the boom period from 1995 through 1998 but also in the down market years of 1990, 1993, and 1994. And, fourth, consumer pressure and intensified competition forced the entire U.S. securities industry to become more customer oriented and more efficient; prices for stock trades and other transactions plunged through the 1990s.

The shift to employee-controlled pension plans succeeded—despite enormous skepticism. Many worried about the willingness of employees to invest in defined contribution plans and of employers to support them. Others worried whether low-income employees or those in small companies would get left behind. But a Fidelity study showed that most employees have embraced the plans, and, between 1989 and 1998, employers’ annual contributions increased by more than $20 billion. Fidelity also found higher participation rates in smaller plans and roughly equal savings rates between active highly paid employees and others.

The recent problems with the 401(k) plans of failed companies like Enron show that pension schemes remain imperfect. We need more discussion of such topics as the use of company stock in retirement plans and the right balance between defined contribution and defined benefit plans. Nonetheless, it remains clear that, overall, consumers have fared very well in defined contribution plans.

A similar consumerist revolution can take place with health care benefits—if companies are willing to give their employees substantially enhanced choice among health plans, much greater control over how much they spend for various health care needs, and much more information to help them make the right choices. Just as we saw with the securities industry, entrepreneurs will respond to the unleashing of consumer demands with clearly differentiated products featuring various combinations of benefits, levels of insurance coverage, payment systems for providers, lengths of policies, and sources of information. The competition among the new products, in turn, will control costs while improving the overall quality of coverage and care. (For more on the myths and realities of consumer-driven health care, see the sidebar “Debunking the Scare Stories.”)

Debunking the Scare Stories

The current health insurance system in the United States has its share of defenders—people and institutions that would stand to lose money or power should the status quo be overturned. These critics have promulgated a number of scare stories about consumer-driven health care intended to deter its adoption. Here are the most common stories—and why they shouldn’t scare you.

The Out-in-the-Cold Story.

Opponents of consumer-driven health care like to paint frightening images of employees cast out on their own into a mystifying health insurance market. Stripped of their employers’ financial support and purchasing clout, they wander about without a map or a sense of direction—aimlessly, futilely—only to emerge so diminished by the experience that some may abandon the purchase of health care altogether. This tale is nonsense. First, most employers do not want to back out of providing health insurance. They are well aware that employees rank health insurance as their number one corporate benefit. Second, consumer-driven health care, like defined contribution retirement savings, will be implemented primarily under the employers’ umbrella. Employers are in a strong position to nourish and support innovative health insurance offerings. Third, consumer-driven health care initiatives should require that employees are, at a minimum, covered for major medical expenses. Finally, the government will play an important part in subsidizing and overseeing the new system to protect consumers against fraud and abuse.

The Not-for-the-Sick Story.

Moving to a more market-based system, some contend, will make it impossible for sick employees to afford health insurance. The insurers with newly differentiated products will offer attractive deals to the healthy and charge astronomical prices to the ill. But this scenario assumes that employers will continue to make the same contribution for all employees, regardless of their health status. In fact, one of the tenets of consumer-driven health care is that premiums must be adjusted for risk. Companies will allot the same pool of money to buying insurance, but they will pay more for the sick and less for the well. The risk adjustment of insurance prices and provider payments will actually encourage the treatment of the chronically ill—and spur the development of innovative, coordinated approaches to their care. It is precisely by undermining the homogenized pricing of the present insurance system that the sick will, finally, receive the excellent, focused care they deserve.

The Class Warfare Story.

Some critics assert that consumerism in health care will benefit only the rich, leaving the poor worse off than before. But this argument is based on two flawed assumptions: that good quality health care is vastly more expensive than poor quality care and that suppliers are interested only in serving the rich and will not innovate to reach the broader population.

In fact, good quality health care—coordinated, technologically advanced, and personalized—costs less than poor quality care. Poor care, after all, undermines health, leading to more illnesses, more procedures, more prescriptions, and more emergencies. And, as in any commercial market, suppliers will be vitally interested in serving the enormous number of consumers who are not rich. No industry ignores the mass market. When consumers take the lead—as in the automobile industry, for example—companies offer a greater variety of better, cheaper products and services, the differences in quality between the best and the average narrow, and all products are of adequate quality regardless of their price.

The Falling-Through-the-Cracks Story.

Proponents of government-controlled health care may argue that the plight of the uninsured will worsen in a consumer-driven system. But the emergence of innovative, lower-cost health insurance products will enable the government to play a bigger role in subsidizing coverage for those who lack it. This is already happening. New plans offered by Blue Cross of California, for example, cover more than 800,000 people in the individual market with low-cost insurance: In Los Angeles, a mother and her children can obtain a policy for as little as $1,400 a year. As consumer-driven health care controls prices and improves quality, the government’s ability to broaden the safety net for the country’s 40 million uninsured will only improve.

The Limited Access Story.

A final myth is that consumer-driven health care will lead to fewer outlets, as providers rationalize their networks to reduce costs. This canard is promulgated by those who are fixated on a bricks-and-mortar vision of health care anchored by a megalith hospital. In a consumer-driven system, by contrast, focused factories for chronic diseases will integrate many different providers in many different locations—ranging from the home, for continual support; to the community, for checkups; to centralized tertiary-care facilities, for complex, high-end care. The idea that we cannot afford this decentralization of care is belied by the magnitude of the current expenditures on chronic diseases. For example, the $54 billion spent in 1996 on the fragmented care of diabetics could support, in each of the 50 states, one 500-bed hospital, five 200- to 300-bed hospitals, and 30 community facilities—all entirely devoted to diabetes and its complications. Such focused factories would, moreover, be much more efficient in delivering care.

To start the shift to a consumer-driven health care system, companies will need to revamp their health benefits in six specific ways:

Give employees incentives to shop intelligently.

A healthy market requires consumers to make rational decisions about how to spend their money. But in the current health care system, consumers are almost entirely insulated from real purchasing decisions; their employers select plans, negotiate terms, and pay premiums. For the system to change, employees will need to shop for health insurance as if they were using their own money.

Here’s how it will likely work: An employer gives its employees the sum it would have spent on their health benefits or lets them contribute their own pretax funds, or both. Employees will be required to use some of that money to purchase, at a minimum, an insurance policy that protects them against financially catastrophic medical events. They will then have considerable flexibility in using the balance to purchase other insurance or care options. Employees who face large, uninsured, out-of-pocket expenses, for example, can trade off the money now spent on insurance coverage they don’t want for the things they need.

Let’s say that my employer puts into my personal health-benefits account $6,000 annually, the money it now spends on my health benefits. I use $4,000 of that money, as required by my employer, for a policy that covers catastrophes. I can then use the remaining $2,000 to purchase a long-term care policy and a policy for prescriptions and reserve a small amount to cover the purchase of new eyeglasses. My coworkers use their accounts to buy different mixes of coverage and care, tailored to their own needs. Because all of us feel that the money is ours, we spend it in our own best interests, avoiding both overinsurance and, through the required catastrophe coverage, underinsurance.

Offer a real choice of insurance plans.

Instead of offering a few indistinguishable managed care plans, companies will need to furnish employees with a broad menu of insurance options, which vary in the following ways:

Types of benefits: Consumers should be able to customize their coverage for long-term care, preventive care, prescriptions, and so forth.

Out-of-pocket maximums: Consumers should be able to trade higher maximums for lower premiums.

Term lengths: Consumers should be able to buy multiyear plans, which can support activities that promote long-term health.

Provider organization: Consumers should have a wider choice of provider types, ranging from broad groups of providers to integrated, multidisciplinary teams of providers specializing in specific diseases, disabilities, or patient groups.

Charge employees actual prices.

Currently, the prices that enrollees pay for health insurance rarely parallel the prices paid by their employers. In 2000, according to a study by the Kaiser Foundation, only 27% of U.S. employees worked at companies that contributed the same amount to all the plans they offered. For more than 60% of the employees, the prices they saw reflected factors other than the actual price to the company. Distortions like this often result from decisions by human resource departments to subsidize certain types of plans to encourage employees to choose them. The HR staffers apparently assume that they can make wiser choices than the employees themselves, but they may instead simply be encouraging wasteful spending. Many people may sign up for plans not suited to their needs because they do not see the real prices.

Making sure that employees see the same prices as their employers will remove this distortion from the system. Studies have shown that health insurance is very price sensitive. According to Health Affairs, for example, when one employer began subsidizing all its health plans equally, many switched to lower-cost plans. The researchers concluded that, in 1994, a price increase of $30 a month would have caused 34% of the enrollees to switch plans. Such rational economic decision making is essential to the establishment of efficient industries—and it depends on price transparency.

Let providers set their own prices.

In the existing system, insurers determine the price they will pay to providers for every discrete “episode” of care. This prevents providers from creating bundles of related services. The resulting fragmentation of care has dire consequences for victims of chronic diseases, who can’t get the integrated care they need, and dramatically increases the costs of the health care system. Consider this: When Duke University’s hospital system created an integrated program for treating congestive heart failure, it saved $8,000 per patient in one year through decreased admission rates and shorter lengths of stay. Costs fell as care improved. Unfortunately, the current payment system penalized Duke for improving quality by reducing the compensation its hospital received: As the number of episodes for which the hospital received payment fell, so did its revenue. Further stifling innovation is insurers’ policy of paying the same prices to or compelling the same discounts from all providers; when excellent providers receive the same kind of payment as inferior ones, the incentive for quality and efficiency is diminished. A cornerstone of a consumer-driven system is the ability of providers to set their own prices not just for individual episodes but for integrated programs of care.

A cornerstone of a consumer-driven system is the ability of providers to set their own prices not just for individual episodes but for integrated programs of care.

Adjust payments for each enrollee based on need.

Under the current system, companies that use insurers generally pay the same amount for health care coverage for every employee, regardless of the employee’s health status. This creates disincentives for insurers and providers to create innovative, differentiated programs that focus on the sick. By varying payments according to individual employees’ care requirements, insurers and providers will be motivated to develop new offerings—for example, multiyear policies that promote the health of people suffering from chronic diseases. A shift to such risk-adjusted pricing will increase neither the employer’s total cost nor the employees’ share of the costs (the higher premiums companies pay for programs tailored to ill employees will be offset by lower premiums for coverage for the healthy); but it will encourage improvements in offerings for sick people. Because insurers will earn more money for policies for the sick, they will have a strong incentive to create plans that attract people with chronic diseases. To avoid concerns about invasion of privacy or job-related discrimination, companies can use neutral third-party intermediaries like Minneapolis-based eBenX to make the risk adjustments. Like other risk adjustment measures, such as the beta measure of financial performance, those for health care will improve with time.

Provide relevant information.

For employees to make reasoned choices about their coverage and care, they need reliable, objective information. Currently, employees have access to some information about insurers, but virtually none is available about specific doctors and hospitals—information that people most want. Companies must provide user ratings of insurers and, more important, of providers, as well as objective data about the quality of care delivered by different providers. This information will reveal differences in quality and performance, which is essential to the effective operation of any market. The government should play an important role here in requiring standardized disclosure of information about the performance of insurers and providers.

For employees to make reasoned choices about their coverage and care, they need reliable, objective information about providers and insurers.

The Trailblazers

Moving to a consumer-driven health care system would clearly entail radical changes. But the good news is that the shift is already starting to happen. A number of innovative employers and entrepreneurs have begun to introduce health insurance products that give employees more choice, more control, and more information. According to Howard Wizig, founding chairman of the Consumer Driven Health Care Association, plans like these now cover more than 500,000 employees in companies such as Aon, Novartis, and Textron.

Medtronic, a $5.5 billion medical-device company, is one of the trailblazers. Headquartered in Minneapolis, a center of the entrepreneurial health insurance movement, the company offers its employees an option of combining a company-paid personal care account with an insurance plan that has a relatively high deductible. In 2001, for example, Medtronic credited $2,000 to the personal care accounts of employees with families who opted for this plan, and in addition it paid for 100% of their preventive care. Employees can use the personal care accounts to cover out-of-pocket expenses for products and services that are rarely fully covered by traditional health plans, such as hearing aids, replacement batteries, and prescription medications for weight loss and impotence. Unspent balances are rolled over to the next year. The plan has paid off. With a $3,000 deductible option, it has a relatively low employee cost of $71 per month, representing nearly a $1,000 annual savings over most of the traditional managed care options the company offers. And it not only gives enrollees greater flexibility in their spending, but it also effectively lowers their out-of-pocket maximums. An employee who has elected a $3,000 deductible, for example, would first use the $2,000 contributed by Medtronic to cover any medical expenses. After this, the employee would be responsible for paying the next $1,000 of expenses. Insurance would then cover any additional in-network health care costs for the remainder of the year. This $1,000 out-of-pocket member responsibility is significantly lower than the out-of-pocket maximums under the other managed care options. Medtronic’s plan is administered by Definity, a small, entrepreneurial company, but many large insurers, including Aetna, Humana, and Blue Cross of California, offer similar plans.

Medtronic’s plan is an example of a creative approach to coverage. Other plans offer different choices in benefits. For instance, Destiny Health, the Illinois-based arm of Discovery Holdings, an international insurance company, has developed an unusual plan that incorporates an aggressive health-promotion program. The plan includes a comprehensive insurance policy to cover hospitalizations, surgeries, and other services for severe conditions as well as a personal medical fund that covers routine health care services. The employer, employee, or both can contribute to the medical fund on a posttax basis, ensuring that the employees have complete ownership of the accounts and can, for instance, roll them over annually.

Wrapped around the health plan is an incentive-based wellness program. Enrollees who follow Destiny Health’s guidelines—by participating in smoking cessation or weight loss programs, for example—earn points that they can use to “buy” benefits such as higher interest levels on their personal medical funds, waivers of plan premiums, mileage credits in airlines’ frequent flyer programs, fitness club privileges, and hotel vacation packages. Members can also earn points for public health activities such as donating blood or learning CPR and first aid. As Ken Linde, Destiny’s CEO, puts it, “We do not just cover our members’ medical needs; we are committed to helping them maintain and improve their overall health and wellness.”

Another important area of innovation lies in the way providers are paid. The Buyers Health Care Action Group (BHCAG), a coalition of large employers in Minnesota’s Twin Cities region, is pioneering a new approach that lets providers name their own prices. The BHCAG contracts directly with 25 care teams, including ones from world-famous institutions like the Mayo Clinic and the Park Nicolette Hospital. Each team, comprising primary care physicians, specialists, hospitals, and other health care providers, determines its own policies, including requirements for referrals to specialists, and independently governs the delivery of health care. Each team also sets its prices for delivering care. Enrollees receive at least enough money from their employers to buy into the plan that has the lowest total cost for care, and they also receive considerable information about their coworkers’ perceptions of the caregivers’ quality. To ensure that providers aren’t penalized for accepting particularly sick patients, BHCAG adjusts its payments for the severity of illness of enrollees.

The plan has received excellent academic evaluations of its impact on enrollees, providers, and companies. According to a study by Jon B. Christianson and Roger Feldman, professors at the University of Minnesota, enrollees responded strongly to BHCAG’s price incentives—when a care team increased enrollee costs by 10%, enrollment fell by at least 16%—and members actively used the information they were given to make choices among the teams. In 1996, 70% of members sought care from high-cost provider groups. By 2001, only 17% were enrolled in the high-cost systems, while 50% were enrolled in the low-cost ones. These shifts do not appear to have affected the quality of care. A recent evaluation shows that providers increased the quality of care for some chronic diseases and health-promoting activities. Most providers applaud the plan. Employers benefit, too; their costs have increased at lower rates for BHCAG enrollees.

Innovative companies are also emerging that supply enrollees with support and information. CareCounsel, based in San Rafael, California, helps mediate insurance-related problems. It recently enabled one enrollee, for example, to successfully appeal Kaiser’s denial of coverage for his claims. Another innovator, Massachusetts-based Consumer’s Medical Resource, has compiled information from academic sources about 43 medical conditions. Clients use this information to seek additional advice from health care providers: One avoided a heart transplant for her child and another disproved a diagnosis of Parkinson’s disease. The Web-enabled tools of Asparity Decision Solutions of Research Triangle Park, North Carolina, help employees and retirees to understand their health plan options and to select the plans that are best suited to their circumstances. For example, retired couples with various chronic conditions use the on-line tools to select health plans that best meet their financial situations, differing coverage needs, and concerns about quality.

There is much to be learned from innovations outside the United States as well. In Switzerland’s consumer-driven system, for example, insurers are experimenting with different terms for policies. One insurer offers a bonus-insurance model that extends over five or more years. Enrollees can obtain progressive reductions in premiums for each year they do not use the insurance policy, which serves to line up the interests of the insurer and the insured in maintaining enrollees’ health. With single-year plans, by contrast, insurers have little financial incentive to invest in healthful practices, because most of the benefits, in the form of reduced health care costs, will occur after the one-year policy has expired and the enrollee may have moved on to another insurer.

These early efforts hint at the wave of creativity that will be unleashed when a consumer-driven health care system takes hold across the vast U.S. market.

The Health Care Revolution

So what will that wave of creativity produce? I foresee health care providers responding to consumer demands by pursuing three dramatic innovations: focused factories of providers that work together to better treat specific diseases or patient groups, integrated information records that consolidate currently dispersed patient information, and personalized medical technologies that enable treatments to be designed for individuals. These innovations will be bundled in a variety of ways by creative insurers. The ultimate result will be better quality care and a more productive health care system.

Let’s look more closely at the three prospective innovations that will spring from consumer-driven health care:

Focused Factories.

Most health care expenditures are spent on treating chronic conditions and their complications. In 1996, according to Health Affairs, just five diseases—mood disorders, diabetes, heart disease, hypertension, and asthma—accounted for 49% of total expenditures and caused an additional $36 billion in work-related losses. Yet, as we’ve seen, today’s health care system is not geared toward the integrated treatment of complex diseases. It’s organized around individual doctors and discrete episodes of care rather than around the comprehensive needs of patients. Our providers are excellent; however, the fragmentation of health care can lead to devastating results, as debilitated victims of chronic diseases vainly struggle to patch together a coordinated system of care.

Consider the 17 million Americans with diabetes, many of whom also suffer from complications such as high blood pressure, kidney and heart disease, and behavioral problems. Diabetics need a team of health care professionals to help them manage this complex, insidious disease—endocrinologists, cardiologists, nephrologists, dermatologists, and podiatrists, among others, who work together to guide patients through the taxing regimens required to maintain their health. Where do they find such a team? The answer, for most diabetics, is nowhere. Instead, they are forced to navigate their own way among various specialists who don’t effectively coordinate services or share information. Gaps and oversights in care, often very serious ones, inevitably result. According to one study, only 36% of fully insured elderly diabetics, for example, receive a biannual glycosylated hemoglobin test, even though it’s essential to their well-being.

The poor care resulting from the fragmentation leads to unnecessarily high costs. Studies demonstrate, for example, that sustained, integrated care could reduce the incidence of costly heart attacks and circulatory complications that plague diabetics by 14% and 37%, respectively. Better coordination could lead to similar improvements in the treatment of other debilitating disorders, saving billions in direct treatment costs as well as the indirect costs of lost work days and premature death and disability.

To solve the fragmentation problem, many health care experts have called for a massive consolidation of the delivery process; they’ve promoted, for example, the vertical integration of hospitals, physicians, and insurers. But, as most businesspeople know, vertical integration is immensely difficult to pull off; the larger the scale, the larger the problems encountered. Nevertheless, following the experts’ advice, hospitals have rushed to buy up physician practices. The number of practices they purchased jumped from 6,600 in 1995 to 19,200 in 1998, a 30% annual growth rate. The result? Disaster. In 1998, the hospitals that acquired physician practices incurred $1 billion in losses—an average loss of $80,000 per physician—as physician productivity dropped and inpatient referrals fell short of expectations. Attempts to merge hospitals and health insurers have met with similarly poor results.

Health care focused factories are a better approach. These teams of providers work closely together to treat specific chronic diseases and disabilities, from asthma to back pain, or to address the needs of currently underserved groups, such as African-Americans, Native Americans, and women. Because focused factories are more modest in scope than everything-for-everybody systems, they are much more efficient and effective—and they’re much easier to manage. In many ways, they resemble the mass-customization production processes that are enhancing manufacturing productivity by replacing cavernous, fragmented, and rigid assembly-line factories with coordinated and flexible team-based ones.

Focused factories can transform health care in much the same way that mass-customization has enhanced manufacturing productivity.

A consumer-driven health care system naturally inspires the evolution of care teams for patients who need integrated coverage. A person with a chronic disease who can freely choose among many health insurance products will likely opt out of an everything-for-everybody system and choose one that provides specialized care for her particular condition—and at a lower cost to boot. In addition, as control over risk-adjusted pricing shifts from insurers to providers, teams will be able to offer bundled services without suffering the devastating economic consequences imposed by the current reimbursement system.

Integrated Information Records.

Closely related to the current fragmentation of patient care is the fragmentation of patient information. Although the need for comprehensive medical records has long been acknowledged, they still do not exist. Data on individual patients continue to be dispersed in the filing systems, warehouses, and computers of various providers and insurers, and there is no strong incentive for their integration. Indeed, the cost and nuisance of trying to combine the fragmented information discourages them from doing so. The current situation, unfortunately, undermines care, leading to errors of commission (for example, an adverse drug reaction from mixing medications prescribed by physicians who are unaware of each others’ recommendations) and errors of omission (failure to have a needed medical intervention at an appropriate time, for instance). In 2001, the prestigious National Institute of Medicine documented the dreadful consequences of not integrating records on the quality and costs of health care in its widely publicized report “Crossing the Quality Chasm.”

Consumer-driven health care will, at long last, serve as a strong impetus for creating integrated records. The reason is simple: Consumers will demand them, seeing them as tools to help them manage their health and their insurance. Innovative organizations will respond to those demands with creative new products and services, just as software companies like Intuit and financial businesses like Fidelity responded to consumer demands for integrated financial records.

Personalized Medicine.

More controversial than the integration of care and information is the potential use of personalized medicine—genomically derived diagnostic tests, drugs, and medical devices—to increase productivity. Few would quarrel with the view that more customized treatments would benefit patients. For example, simply screening drugs against a person’s genetic makeup could reduce many dangerous reactions. One Journal of the American Medical Association report revealed that more than half of the 27 drugs frequently cited for causing adverse reactions were linked to genetic variations in patients’ ability to metabolize the drugs. Nevertheless, many health policy experts essentially dismiss such benefits; in their eyes, personalized medicine and other new technologies will simply lead to higher costs, putting medicine beyond many people’s reach.

Such predictions are built upon blinkered economic frameworks; they ignore the fact that increasing costs in one sector of the economy can actually enhance general productivity. In recent years, many companies have, for instance, considerably increased spending on computers, in the belief that the resulting productivity gains will generate more than commensurate increases in the volume and quality of their products. The same dynamic would take place in health care as personalized medicine begins to reduce the need for other types of costly care and increases the productivity of workers. A study by Harvard professor David M. Cutler and Stanford professor Mark B. McClellan clearly shows the payoffs of technological advances in medicine. Their research documented productivity and quality-of-life benefits that exceeded the additional costs of new technologies for treating heart attacks, low-birth-weight infants, depression, and cataracts. Similarly, recent studies of the efficacy of new drugs reveal that they frequently cause overarching reductions in total hospital costs. And new medical innovations appear to be increasingly cost-effective: studies show, for example, that new drugs brought greater improvements in well-being and work loss than older ones. That is not to say that every new technology pays for itself but rather that, taken as a whole, new medical technologies will likely create economywide benefits in excess of their costs.

If history is any guide, American consumers are unlikely to accept the experts’ doubts about personalized medicine. As the benefits of the new technologies become clearer, patients will demand better, more tailored treatments. In a consumer-driven health care system, they will receive them. The resulting improvements in health will end up increasing general productivity.

Against the Grain

The idea of putting consumers in charge of health care rubs many in the health establishment the wrong way. It goes against the grain of traditional ways of working and thinking, and it threatens to upset long-established practices and ideologies. Some critics argue that consumer-driven health care will widen the divide between the haves and the have-nots. Others believe that the only way to control health care costs is to ration care under the aegis of a single-payer, government-controlled system. Still others contend that people aren’t sophisticated enough to make their own decisions about coverage and care.

Underestimating the intelligence of consumers is nothing new, of course. We heard many of the same fears when the idea of giving people control over their retirement savings was first raised. The fears were unfounded then—and they will prove unfounded with health care. Individuals are highly motivated to educate themselves about their health, their insurance, and their care and to shop responsibly, seeking the most value for their money. Promoting that economic dynamic—the dynamic of consumer markets everywhere—is the best way to enhance the health care industry’s productivity and quality. It’s time to put our trust in the good sense of the American people.

Regina E. Herzlinger is the Nancy R. McPherson Professor of Business Administration at Harvard Business School in Boston. She is the author of Market-Driven Health Care (Perseus, 1997) and the forthcoming Consumer-Driven Health Care (Jossey-Bass, 2002). She chaired Harvard Business School’s Consumer-Driven Health Care Conference in 1999. She can be reached at rherzlinger@hbs.edu.

Partner Center

The email and password entered aren’t matching to our records. Please try again, or reset your password. If you have a username from our previous site, start by using that. Please See our FAQ for more.

If you are signing in for the first time on the new HBR.org but have an existing account, please enter your existing user name and password to migrate your account.Please see Frequently Asked Questions for more information.